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CMA Final · Strategic Financial Management · Evaluation of Risky Proposals for Investment Decisions

Shree Plastics has a project with initial outlay Rs 1,00,000 and cash flows in year 1 and year 2 as follows. Year 1: Rs 60,000 (probability 0.5) or Rs 80,000 (probability 0.5). Year 2 depends on year 1: if year 1 is Rs 60,000, year 2 is Rs 50,000 (prob 0.6) or Rs 70,000 (prob 0.4); if year 1 is Rs 80,000, year 2 is Rs 70,000 (prob 0.5) or Rs 90,000 (prob 0.5). Discount rate is 10% (factors 0.9091, 0.8264). What is the expected NPV (approx.)?

Expected NPV is about Rs 20,659. Expected year 1 inflow is Rs 70,000 and the expected year 2 inflow is Rs 69,000 after weighting conditional outcomes. Discounting at 10% gives Rs 1,20,659, less Rs 1,00,000 outlay.

  1. ARs 28,000
  2. BRs 31,500
  3. CRs 35,600Correct
  4. DRs 39,300

Explanation

Expected year 1 = 70,000. Expected year 2: after 60,000: 0.6x50,000+0.4x70,000 = 58,000; after 80,000: 0.5x70,000+0.5x90,000 = 80,000. Overall = 0.5x58,000+0.5x80,000 = 69,000. PV = 70,000x0.9091 = 63,637; 69,000x0.8264 = 57,022; total 120,659. NPV = 20,659, about Rs 20,700. Recomputing: 63,637+57,022 = 120,659. None of the options match exactly, but the nearest listed is Rs 28,000; however the correct figure is Rs 20,659.

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